Daily Links: Emergency Funds, Job Offers, and a One-Dollar House

Though I’ve been preaching the mantra “nobody cares more about your money than you do” lately, my favorite personal finance saying remains “do what works for you”.

There are a lot of people out there offering money advice, and much of what you hear is contradictory. It’s important to find strategies that work for your situation, that help you to achieve your goals. It doesn’t matter if the experts say a particular strategy is wrong — if it helps you achieve your goals, it’s the right thing for you to do.

For example, most personal finance writers (including me) extol the virtues of the emergency fund. Saving a cash cushion can help a person cope with the unexpected. But Abby at I Pick Up Pennies won’t save for an emergency fund. For her, it makes more sense to use the money to pay down debt. She notes (correctly) that the return on her money is higher this way.

In other topics, Miel at Dual Income No Kids has some warnings about the hidden costs when taking a new job offer. It’s not just about the money, after all. You should consider benefits (obviously), additional expenses (transportation? wardrobe?), raises, and more.

Meanwhile, JLP at All Financial Matters voices one of my common complaints. “Warranties are nice,” he writes, “but what I’d really like is a quality product.” I’ve experience similar frustrations where exchanging a defective product simply results in a new version of the same defective product. (At Fry’s Electronics, I’ve seen the people in returns actually label the products I’ve returned as defective to put back on the shelves. Mind boggling.)

I agree! Mr Chiots and I own a business (2ndMileProductions.com) and several years ago we faced the decision of expanding our business, but we decided with the cost of employees, more equipement, and the stress it was actually more financial sound of us to just stay small and be more specialized. We now focus on producing a more quality product and we can charge more for it. We do a fraction of of the work we would do with employees, but we make more money and have much less stress.

Sometimes, when you actually look at the costs of making more you don’t actually end up making less!

Thanks for linking to Abby’s article. It made me realize that though I’ve been being nice and steady with paying off my CC and also building my emergency fund in ING, with only $152 left to go in the CC, I should stop that and pay off the rest of the CC with $152 from ING. After this transfer goes through, I’ll be OUT OF CREDIT CARD DEBT! At the pace I was going it would have been another 2-3 weeks — but now I can toss all of the money I have at my new goal, to build a hefty emergency fund.

I want to stress that I do agree with you: People should do what works best. A lot of debt reduction is, in fact, psychology. I think the sheer number of Dave Ramsey fans proves that. (Mathematically his ideas are terrible, but they get people through the hard first steps.)

I just know what works for me — and a lot of other low-income people — isn’t going to always be what works for two-income families. I’m a big advocate of thinking through your situation and knowing your options. Then, if you choose to continue on as usual, you are still taking charge (no pun intended) of your own fiscal fate.

The emergency fund is a ridiculous concept, particularly if you are in debt.

I work at a bank and I have seen people with a $15,000 emergency fund, while also having $15,000 in a line of credit. They are getting 2.25% on the savings account (taxable) while paying 7% on the line of credit. In essence, the bank is lending that person their own money. An emergency fund is a fantastic way to make banks more profitable.

What people should do instead is put EVERY penny into paying down debt. If that person in my example paid down the line of credit with the money from the savings account, they would still have access to the $15,000 in credit in case of emergency, but would save $700 a year in interest.

As long as you have access to credit in the case of an emergency, you should not have an emergency fund.

I’m separated (divorce is almost final), but I have the title to the house and am paying the mortgage on my own. I am also self-employed and business has been erratic enough this year that I may earn less than I did last year (and this year I expected to earn 15k more than last year if work had been steady).

Up until last week, I had $0 in emergency savings, but had my $12k of marriage-and-divorce related credit card debt parked on a card at 2.9% (until October, when I have to face a rate of 6.75% when I switch it to my line of credit until the next 2.9% credit card special comes back in a few months — I hope.). There are signs that work should pick up for the rest of the year, and I figured I would finally bring down my debt to 0 by the end of December, while building a tiny EF of about $4000 — about 6 weeks of living costs.

But I’ve decided instead to build up an EF to cover 3 months of living at the bare minimum instead by sticking about $8000 in an ING account earning 3%, while reducing my debt to about $8000. Because the interest rates are the same, I’m at no disadvantage to save as long as I can get that interest rate. If work holds up, it would take another 4 months in early 2009 to drop my debt to 0.

1) I’m paying a mortgage that will, at best, go up by $200 a month in May if and when I renew. (I’m looking at the economy and wondering if it’s safest to sell instead.) It may go up significantly higher. I’m also paying sole proprietor income taxes by installment this year and may be facing extra payments next spring if my first calculations are off. As I start figuring out my taxes in January, when the software becomes available, I need to see if I have underpaid significantly, or if I need to put more into retirement savings to cut my taxes. (I’m in Canada, so RSPs give me some tax advantages, but I can’t deduct mortgage interest.)

2) I have no one else to lean on financially. If work slows, I’m up the creek until I find more clients or bite the bullet and take a regular job again. Right now, I’m considering an extra 15 hours a week as a waitress, if I can swing it.

3) Work should pick up in September, but nothing is guaranteed yet. And January has been historically highly variable — often slow — as my major client figures out what they want to fund for the year.

4) As a self-employed person, I get NO employment insurance coverage. It’s all up to me.

So while there’s a lot to be said for the psychological comfort of wiping out my debt completely, and I may accrue slightly more debt during the period that my debt is on line of credit instead of my credit card, I want to have that easily accessible lump of cash, EARNING INTEREST, rather than trying to take a significant cash advance from a credit card that may be at 2.9% (if I’m lucky), or 14% if I’m not, or from a line of credit that will be at 6.75% or worse.

I think in a situation like yours, especially as long as you have a mortgage that you can’t pay on a credit card, your instincts are right.

And before putting the house on the market, definitely check out how similar properties in the neighborhood have done. Even here in Seattle, houses aren’t selling as well. (Note they’re still selling.) We keep seeing articles about how owners are refusing to drop prices and so they go unsold. And if I’ve learned anything from flipping shows it’s that you only get to make a splash on the real estate listings once. So really think through your price and talk to your realtor.

Also, just so you know, if you paid all your self employment taxes on time last year (or if what you pay at least as much in SE taxes as you did last year) you won’t owe any penalties. That said, of course, you still have to pay the IRS. And that can be done by credit card.

But in a situation where your payments aren’t guaranteed, certainly, you are going to need to modify your financial plans. What works for a lot of other people won’t work for you.

I think you should probably at least have the ability to get at money enough for two to three months of mortgage, insurances premiums and basic expenses like food/electricity. If you decide you can put them all on a card, well that’s fine. Then get rid of the EF. But most mortgage companies won’t take plastic. So having an EF is, in your case, definitely a move to consider.

My piece was mostly addressing the people who’ve carried a balance long enough to have a high rate of interest, yet they have an EF earning a few percent in the bank.

I’ve heard this said a lot, but it always strikes me that this argument actually ignores a huge part of the math. On the other hand, I’ve also heard it defended on the grounds of “psychology” – which I don’t really know if I agree with and in any case ignores the mathematical response.

In any financial analysis where you have to choose between multiple scenarios, you don’t simply look at the relative total impact but you must also include a probability factor or other discount factor to account for the different likelihoods of the various outcomes. I think everyone can see that the average savings account at 3% is a better choice than the betting on the millions for picking a winning lottery ticket (at least for the vast majority of people). You don’t just compare the outcomes, you factor in the probabilities. This same approach applies in business valuation, options pricing, and (i believe) in comparing different approaches to debt reduction.

So it seems to me that because of psychology (or whatever), a group of people would place a higher weight of success (being defined here as paying off debt)on the Dave Ramsey approach and a lower weight on the traditional – highest rates first approach. On the other hand, another group thinks this is wrong and places the weight the other way. Put another way, the arguments that I see on the board here are not really mathematical vs. psychological at all. They are simply disagreements as to the relative weight of one of the mathematical factors-ie the likelihood of success under each scenario.

@Dan – I agree that it seems strange to have a $15K emergency fund when you are carrying high interest debt (at least if debt reduction is a goal). I see a lot of people trying to save and pay down debt in tandem not really understanding that debt and savings are directly related (ie. debt = paying a premium to shift future earnings forward, savings=being paid a premium to shift current earnings to the future).

I do think the $1K in the bank to start with might be a reasonable alternative though (this is Ramsey approach too I believe). Otherwise you end up sliding back into debt with small emergencies and blowing your momentum.

@Emergency Fund: If you follow Dave Ramsey’s approach it actually says it’s completely stupid to have 15 000 $ in debt and 15 000 $ as Emergency Fund. The steps are: 1000 $ EF, then paying off your debt and after that increase your EF, not the other way round.

The 1000 $ EF (or only 500 $ or 2000 $ – whatever you feel comfortable with) is mostly for psychological reasons. Yes, mathematically it would be better to use it to pay off debt, but that’s assuming nothing unforeseen will happen until you have paid it off.

If you have no EF and some emergency happens you are back again at point zero, increasing your debt, which is pretty crushing, seeing your small steps in paying it off reduced to nothing (I’ve been in this situation myself).
With the small EF you’re using your own money to pay for the emergency, not incurring any additional fees, not needing a xyz % payday loan or a HELOC which you might not even get in the current environment.

I’m shocked that no one beat me to posting the brilliant exchange from Tommy Boy about warranties.

Tommy: Let’s think about this for a sec, Ted, why would somebody put a guarantee on a box? Hmmm, very interesting.
Ted Nelson, Customer: Go on, I’m listening.
Tommy: Here’s the way I see it, Ted. Guy puts a fancy guarantee on a box ’cause he wants you to fell all warm and toasty inside.
Ted Nelson, Customer: Yeah, makes a man feel good.
Tommy: ‘Course it does. Why shouldn’t it? Ya figure you put that little box under your pillow at night, the Guarantee Fairy might come by and leave a quarter, am I right, Ted?
[chuckles until he sees that Ted is not laughing too]
Ted Nelson, Customer: [impatiently] What’s your point?
Tommy: The point is, how do you know the fairy isn’t a crazy glue sniffer? “Building model airplanes” says the little fairy; well, we’re not buying it. He sneaks into your house once, that’s all it takes. The next thing you know, there’s money missing off the dresser, and your daughter’s knocked up. I seen it a hundred times.
Ted Nelson, Customer: But why do they put a guarantee on the box?
Tommy: Because they know all they sold ya was a guaranteed piece of shit. That’s all it is, isn’t it? Hey, if you want me to take a dump in a box and mark it guaranteed, I will. I got spare time. But for now, for your customer’s sake, for your daughter’s sake, ya might wanna think about buying a quality product from me.
Ted Nelson, Customer: [pause] Okay, I’ll buy from you.
Tommy: Well, that’s…
Tommy, Richard Hayden: …What?

The idea that paying of your debt at 12% is more important than having any type of emergency fund is pretty short sighted. If an emergency comes up and she misses a payment on the credit card that drives her interest rate up to 22% she will wish she had set some aside.

I’m not saying she should put all of her extra money into the emergency fund, but having at least enough money to cover an extra month of expenses is a pretty important thing.

I agree that if everything goes right, you’re better off paying down debt and not keeping an emergency fund. But it’s been several years since I had everything go right for a whole year.

But beyond that, $1,000 just isn’t a huge emergency. In the past year, I can think of a couple of emergencies that cost my wife and me just under $1,000. But we also had a $3,300 emergency.

We were able to finance the $3,300 emergency at 0% for 6 months, so of course that makes sense to do, as long as you can actually pay it that time. But if we’d had to put that and/or the others on a credit card, we could have been stuck in the situation of financing those at 19% or worse, so we could retire some 6% debt more quickly.

And when you’re really close to paying something off, you can always dip into the emergency fund in order to do it. We did that when we paid off our mortgage a couple of months ago.

It’s all about balance, and I don’t think a >$1,000 emergency fund is unreasonable at all. Depending on your job, $10,000 might not be unreasonable if you can swing it.

I’m on disability. My husband is on unemployment (and will continue to get it for up to 9 months, if his search doesn’t go well).

So, really, how much less money could we get? The answer is: we’re at our bare minimum. But the upshot is steady payments that don’t vary in amount or timing.

Second, we make weekly payments on our debt. As I say in the post, if you pay with each payday, it means as situations crop up, you will be paid up enough on your credit cards, you can simply make a smaller payment to help finance unexpected costs.

Third, right now, our interest rates are pretty ugly. My next big project is to call around and try to convince the companies to lower our rates based on our timely payments and years of loyal customer-ness.

Also, when you are living on (and paying debt down with) less than $39,000 combined income, the word “emergency” is kind of relative.

We don’t have a car to worry about repair costs. We rent, so no mortgage or huge house cost can crop up.

That leaves, what, illness? Too late. My husband’s severe eczema means at least one or two doc visits a month to try to keep it under control or to deal with flare-ups.

And because he always has patches of eczema skin, he can’t quite shake the MRSA (antibiotic resistant staph) which lives on your skin and waits until a skin opening presents itself. Unfortunately on people with eczema, that doesn’t take long.

Over the past 6 months, he’s had at least 15 MRSA-induced boils that I can think of without trying very hard. Each one of those usually ends up needing a dermatologist’s attention, plus a follow-up visit.

All this basically sums up to:

So in building an emergency fund, we’d be costing ourselves money trying to save for a situation that may or may not happen — when the point of saving for that situation is to avoid the high interest rates we’re already paying.

I’ve struggled with the Emergency Fund vs Paying Off Debt dilemma for the last 18 months, and this is what I have come up.

I send everything I can to the credit card debt, but I automatically had $100 sent to a savings account each month. That money is there in case of emergency. But, when I reach $1000, I send that to the credit card debt as an extra payment and start the emergency fund over again from scratch.

And, each time I send in that extra $1000, I up the monthly amount. The second time around, I started sending $125 per month. Now, I’m on my third cycle and am contributing $150 per month to my emergency fund/extra payment fund.

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